European and Non-European Emerging Market Currencies: Forward Premium Puzzle and Fundamentals

Peter Backé () and Franz Schardax ()
Additional contact information
Peter Backé: Oesterreichische Nationalbank, Foreign Research Division, http://www.oenb.at
Franz Schardax: Institut für Quantitatives Asset Management (IQAM), http://www.oenb.at

Focus on European Economic Integration, 2009, issue 2, 56-66

Abstract: The empirical literature has consistently rejected that the uncovered interest parity (UIP) theorem holds in practice, thus posing the well-known forward premium puzzle. In this study, we examine this issue for a sample of 18 emerging market currencies and, in addition, for a subsample of 6 currencies from emerging Europe. We first confirm earlier evidence for the existence of a forward premium puzzle for emerging market economies. We then extend the model with a view to exploring systematic relationships between excess returns from investments in foreign currency and country-specific economic fundamentals. Subsequently, we use this extended model to generate out-of-sample forecasts of currency returns. We also test for forecast accuracy, confirming that these forecasts are superior to naïve forecasts. Our results show that investments based on these forecasts generate considerably higher returns than alternative investment strategies. This applies in particular to our full sample of 18 emerging market currencies. For the subsample of 6 currencies from emerging Europe, profits per trade for the model-based forecasts also outperform those generated by the other investment strategies, but by a smaller margin. These results suggest that, compared with currencies of advanced countries, the smaller bias in the forward exchange rates of emerging market currencies found in the empirical literature could relate to the better predictability of currency returns for emerging market currencies.

Keywords: Forward bias; emerging market currencies; forecasting (search for similar items in EconPapers)
JEL-codes: F37 G14 G15 (search for similar items in EconPapers)
Date: 2009
References: Add references at CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
https://www.oenb.at/dam/jcr:24c5203f-616b-4ee1-a03 ... cke_tcm16-137027.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:onb:oenbfi:y:2009:i:2:b:1

Ordering information: This journal article can be ordered from
Oesterreichische Nationalbank, Documentation Management and Communications Services, Otto-Wagner Platz 3, A-1090 Vienna, Austria

Access Statistics for this article

Focus on European Economic Integration is currently edited by Julia Wörz and Elisabeth Beckmann

More articles in Focus on European Economic Integration from Oesterreichische Nationalbank (Austrian Central Bank) P.O. Box 61, A-1011 Vienna, Austria. Contact information at EDIRC.
Bibliographic data for series maintained by Elisabeth Beckmann ().